Setting up a new business can cost you a fair bit of money. You're likely to spend on office space, equipment, and utilities – which can quickly add to your expenditure. Thankfully, it is possible to recoup some of the money you've spent by deducting expenses on your federal tax return.
However, it is generally not allowed to claim the full cost as a deduction in the first year. Instead, you can deduct a part of your costs each year by claiming a depreciation deduction, which you must report on IRS Form 4562.
Form 4562: Depreciation and Amortization is an Internal Revenue Service (IRS) form used to claim deductions for the depreciation or amortization of an asset for tax filing purposes. It is submitted along with your federal income tax return every year that you claim this deduction.
Let's say you are an architect and recently spent some money on upgrading your website and purchasing new laptops. You also purchased an office space to accommodate your growing team. Now, you want to write off the costs for buying the property and new equipment as a business expense.
However, you won't be allowed by the IRS to deduct the entire cost in one year. Instead, you can deduct a small portion of the expenses for multiple years by claiming a depreciation deduction on IRS Form 4562.
Several benefits are provided to small business owners to encourage entrepreneurs and creatives, including deductions for business expenses to reduce their tax burden. IRS Form 4562 allows business owners to claim a deduction for both depreciation and amortization.
The IRS defines depreciation as follows:
"Depreciation is the annual deduction that allows you to recover the cost or other basis of your business or investment property over a certain number of years. Depreciation starts when you first use the property in your business or for the production of income. It ends when you either take the property out of service, deduct all your depreciable cost or basis, or no longer use the property in your business or for the production of income."
Depreciation deals with tangible property, something you can touch, like a car, a laptop, or a building. Amortization is also similar to depreciation, but it is used to depreciate the value of intangible assets, such as your goodwill, intellectual property, and the cost of starting a business.
You only have to file IRS Form 4562 if you deduct a depreciable asset on your income tax return. You are also required to file Form 4562 for every year that you continue to depreciate the asset. Usually, you need to file IRS Form 4562 to claim any of the following:
Once you have filled up your IRS Form 4562, you need to file it as part of your annual business tax return in the same year you purchased the asset you want to depreciate or amortize.
IRS Form 4562 is divided into six parts, and we will discuss each part in this step-by-step guide. You can clarify any further doubts by checking out the IRS instructions for Form 4562.
We also recommend you keep the following information handy before you start filling out the form:
Section 179 of the IRC allows you to take an immediate deduction for business expenses related to depreciable assets, including equipment, vehicles, and software. Suppose you have qualified property eligible for deduction under Section 179. In that case, you need to make an election for the same in Part I Form 4562. Here's the information you need to fill up in this part.
In Line 1, you have to enter the deduction you are claiming. Typically, you can deduct a maximum of $1 million in a year. This limit reduces if the asset costs more than $2.5 million. If the latter holds, the reduction will be applied in Lines 4 and 5 of the form.
Line 6 is where you will list the assets you are depreciating. If you use the asset solely for business purposes, list the price. If you aren't depreciating the full value, you will list the amount under elected cost.
Suppose you wrote off a portion of a listed asset in the previous year, and the rest of its value was carried over and is depreciating this year. In that case, you will enter that amount in line 10. The next line, Line 11, is the maximum amount you can write off in the tax year. It would either be your net earnings/profits for the year or the amount in Line 1, after considering any reduction limits in Lines 4 and 5.
Line 12 is where you enter the total amount you are deducting. If it is higher than the limit on Line 11, simply enter the value from Line 11. The last line, Line 13, tells you how much carryover depreciation you will have in the subsequent year. To get this figure, subtract Line 11 from the total amount you are writing off.
In this second part of Form 4562, you will list any type of special depreciation you're claiming, including bonus depreciation. This type of depreciation only applies to certain qualified property, and it's best to meet an expert to get your status right regarding special deduction. You can read the instructions for this section on the IRS site if you think you may qualify.
Part III of Form 4562 is meant for listing Modified Accelerated Cost Recovery System deductions (MACRS). This section is relevant if you plan to depreciate the property over multiple years instead of writing off as much as possible with Section 179.
This is also the section where business and income-producing real estate are listed. The period for which you can depreciate property is determined by the Modified Accelerated Cost Recovery System (MACRS) guidance issued by IRS.
While filling up this section, in Line 17, you must enter the deduction for assets that were placed in service during the year for which you're filing. The details about the assets go on lines 19(a) through 19(i).
Part IV of Form 4562 is where you will add the total amount of depreciation from each part of the form. You will enter this amount on Line 13 of Schedule C for Form 1040.
Unfortunately, this part where the IRS wants you to summarize your deductions falls right in the middle of the form. Generally, you're better off skipping this section and completing Part V of IRS Form 4562 before returning to Part IV. That's because Line 21 requires you to enter the value of your listed property that's also used for personal use (which will be listed in Part V).
The next line, Line 22, will list your total deduction. You needn't fill this up if you're filing for a partnership or S corporation.
This part of IRS Form 4562 is used for depreciating listed property, which refers to the business property also employed for personal use. For instance, a vehicle that you use for your business and dropping your kids at school.
Part V of IRS Form 4562 is divided into three sections.
In Section A, you will enter the depreciation allowance for listed property, but you must have evidence to support the deductions you are claiming.
Section B is meant to be filled by sole proprietors and partners to provide additional information on vehicles used for business purposes.
Section C is filled up by employers to provide information on the vehicles provided to their employees. It comprises five yes-or-no questions. You needn't fill it up if you don't have any employees.
Part VI of Form 4562 deals with the amortization of intangible business expenses. These costs are not related to any purchase of physical assets. Instead, these are expenses for intangible assets such as goodwill and trademarks. To fill out this section, you need to include a description of the amortized costs and other details.
However, filling up Part VI is often tricky because it is hard to ascertain the value of intangible goods. For example, how do you put a price on your goodwill, and how do you justify it? It's best to consult a CPA or a tax advisor if you're going to amortize assets than simply guess the worth of your intangible assets.
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